Dear Dr. Krugman, It's About Sovereignty, Not The Liquidity Trap

by: Cullen Roche

In a story today Paul Krugman is again citing his most recent epiphany – that a nation that issues its own currency makes it distinctly different from those that don’t issue their own currency (see here for more). He says:

Anyway, I was referring to interest rates. Ezra Klein points out, correctly, that the big economic story of 2011 was that the conventional wisdom of Washington about the urgency of deficit reduction was totally contradicted by the bond market. But Ezra makes at least a slight nod in the direction of a new conventional wisdom, which says that it’s about the unique safe haven status of the United States:

This is not, to be fair, a bet on America’s economic strength. It’s a judgment about the rest of the world’s economic weakness. U.S. Treasuries are what savvy investors buy when they’re in a canned-goods-and-ammunition sort of mood and they think gold is overvalued. But though that makes the demand we’re seeing more depressing, it doesn’t make it any less real.

What such stories miss is the fact that interest rates have dropped sharply for every country that borrows in its own currency.

Of course, MMTers have been pointing this out for decades and it’s why we predicted the Euro crisis so long ago. But Dr. Krugman doesn’t quite close the loop here. He is still pushing the reason for low yields as being something relating to the liquidity trap and the myth that the “moneyness” of bonds is suddenly negligible when compared to cash. He says:

What we’re looking at is a world of depressed demand, where government securities look like a good buy everywhere except in countries that either don’t have their own currency or have large debts in foreign currency, making them vulnerable to self-fulfilling panic. It’s a world in which deficit obsession is mad, bad, and dangerous.

What he’s missing is that none of these nations “borrow” their currency (he cites Japan, the USA, UK and Sweden). Why in the world would you “borrow” a currency you have monopoly supply of and an endless ability to create? You wouldn’t. Dr. Krugman is SO close to closing he loop on all of this, but he’s working from the totally defunct convertible currency paradigm. As sovereign currency issuers these countries are not dependent on bond markets to acquire money for “funding” purposes. When these nations want to spend they simply reach into their bottomless pit of money and credit bank accounts. Like a scorekeeper at a football game, these nations don’t have piles of “points” (or money) sitting around waiting to be spent. They don’t acquire points from the teams playing the game. And these four countries, just like the scorekeeper, don’t acquire money for spending purposes when they want to. They simply credits bank accounts. The scorekeeper wouldn’t “borrow” the points he has monopoly supply of would he? Absolutely not. The key is that the sovereignty eliminates the bond vigilante myth so that bond markets serve as a tool for the central bank to target interest rates as opposed to being a “funding” source as we see in non-sovereign nations such as Europe’s nations. See here if you’re at all confused on this subject.

So Dr. Krugman, it’s not about the liquidity trap or any sort of abnormal or temporary environment (see here for more on the liquidity trap myth and political biases). It’s always about being sovereign in one’s currency. But of course, mainstream neoclassical economists are hesitant to admit as much because it would be the equivalent of admitting that much of your career’s work is entirely wrong and/or based on defunct myths. You’d also have to give the MMTers credit for absolutely nailing these points time and time again over the last few years. This is our Copernican moment. MMTers are calling the profession out for claiming the Earth is the center of our solar system. Unfortunately, the most prominent economists in the world can’t admit that this is sheer myth….And we’re all worse off because of it.